Getting Down to Business: Dogs of the Dow Part 2

The Blind Squirrel Diaries

Welcome back to the continuation of my series regarding the Dogs of the Dow theory of investing. Last month I covered some of the basics of how this process works, the history of its development and the people responsible for it, and some performance data to give investors an idea of how things have worked out over time for people that choose to have some part of their overall equity positions managed in this fashion. If you missed that first article and would like to review it before moving into this second part (and I recommend you do), you can see it here.

But if you are in a hurry to move forward, here’s a very basic outline of the previous facts as presented.

The Dogs of the Dow theory was brought to life in late 1990 by Michael O’Higgins, a money manager in Miami Beach, Florida. He published a book entitled Beating the Dow that explained what his research into this methodology had uncovered and went on to lay out how to establish an account and use the system for yourself. Copies of that book are still available online at Amazon or Barnes and Noble.

These are the steps an investor must follow to get an account set up under this system:

Find a table of the DJIA 30 stocks that shows the share price as of the last business day of the year and either the current annual dividend or the current yield. If your table shows the annualized current dividend but not a yield, calculate the yield by dividing the annual dividend by the stock price. You will need that yield number in a moment. If you are doing this at any time other than year-end, that’s OK. Just go with the current share pricing and dividend/yield as it exists at the moment.

Sort the 30 stocks by yield, placing the highest yielding issue first, then the second highest, etc., until you have identified the 10 highest yielding stocks in that universe.

Decide how much money you want to devote to the strategy. A minimum of $10,000 is recommended, but as an absolute minimum you can think in terms of $7,500. That’s just to keep the cost of commissions down to a level where they don’t take too much away from the results in terms of % cost.

This is optional but highly recommended: Open a new account to hold only these stocks. Reason? So you can track performance accurately. If you mix these positions in an account with others you’ll have the Devil’s own good time figuring out how they did at year’s end.

With the new account set up, transfer in the cash you are willing to invest. Then spread that cash equally (in dollars, not shares) over the ten selections. Decide if you want to take your dividends in cash as they are paid for personal use, or if you don’t really need the cash currently. If you don’t need/want the income stream, when you make your buys, indicate that the dividends are to be reinvested in full and fractional shares of the paying security as received (known as a D.R.I.P. plan, “Dividend Reinvestment Program”). Reinvestment is recommended but not required. You can also choose to have the dividends paid into the account and just held there for future use if you desire. If that is your choice, there will be a way to get that sum reinvested later if you want.

Now, with the calculations made, the account set up, the shares purchased, and the way to handle dividends established, just one final thing remains: Sit back, relax, and let the system do its work for you! Could anything be easier to understand and deploy? If so, I don’t know what it is.

At the end of the calendar year in which you got started you must make your annual adjustments. This involves rebalancing the share allocations and making any stock position changes if warranted. Rebalancing is perhaps the most challenging part of this process. I’ll have a lot more to say about it later in this message, so stay alert for that.

Note: If you are getting started at any time of the year other than the first business day of a new calendar year, that’s fine. I call that the “stub year”. Just make the yield calculations as described for that moment and buy the indicated securities. But please note this recommendation: if you are setting up on or after October 1st, I found it reasonable to buy only the first 8 stocks on the list and hold off for the number 9 and 10 positions for the time being. The reason for that is because, once you get down to that last two or three stocks, the yields are often so very close to one another that over a short time frame the companies can change as share price moves about a bit. If you bought the full compliment of 10 in, say, mid-November, when January 2 comes around just six week later you might find that those last two buys are now number 12 and 14 or so. Something else will have replaced them and you have to sell in such a short time frame. It’s usually not worth that, so just keep the cash in the account and be patient, wait to see what the new year brings and then fill out the remainder of the positions. Then start the new year with the proper 10 positions in the account and use that as your anniversary and realignment date in the future.

I also covered some historical results comparing the Dogs theory yearly results with that of the DJIA 30 and the S&P 500. The overall results show favorably for the Dogs, although they don’t beat those averages each and every year. But, over reasonably long time frames, 10 to 20 years, they tend to do so on average. And that’s a big part of the attraction for investors. A simple way to be in equities with results that could outpace the major indexes with little effort, time, or expense.

I also talked a bit about my own experiences as a Financial Advisor with clients that participated in a program I devised in 1992 based on this theory. I wrote a marketing brochure to use with prospects that detailed all the performance numbers from 1972 through 1997 (the last year I was allowed by my firm to write and publish this brochure on my own) as well as answering a lot of commonly asked questions and the way I helped them run the account. You can see the last edition of this brochure here. I suggest you have a look at it. Lots of information presented concisely as well as performance data for years that are hard to find nowadays.

Now, let’s get on with this and cover some new and informative ground. We’re going to peek behind the curtain a bit to see what it is really like to manage money with this system based on my real-life experiences with clients. It’s one thing to read and talk about it. It can be quite another to execute it, as you will see.

For Whom Doth This Bell Toll?

Now that you have a grasp of how the Dogs of the Dow system works, and how to implement it for yourself, the question to answer is this: is it right for you?

The answer to that can’t be found in a textbook or by applying some cookie-cutter application. The answer is highly personal and depends on many factors, factors that are specific to you and your situation. Not everyone is a prime candidate here. But many are, at least as far as my experience has shown me.

You see, a lot of readers on this site are more well informed, talented, and educated than the general populace of investors. They are rather sophisticated in their approach to investment research, selection, and timing of buys and sells. For them, this may seem too simplified, too basic to warrant attention. I get that – I truly do. But in the greater scheme of things, a much larger audience doesn’t share those characteristics due to time, interest, or ability. And there are some who are just basically uninterested in this entire process of investing, preferring instead to find a knowledgeable and trustworthy professional to handle this for them. There is absolutely nothing at all wrong with this. Not everyone is cut out to be their very own professional investment expert. This is true for many things in life. If your car needs a new fuel pump or a/c compressor, do you run out to the auto supply store, buy the parts, and install it yourself? If your child is running a fever, coughing and having trouble breathing, do you go directly to a medical advice website, read and do your own diagonisis, then get to the pharmacy to buy the medication needed to solve this health issue? I hope not. And so it is true here as well. Depending on your own needs and abilities, finding a way to invest with confidence in a simple system that can be worked with minimal effort and brain-straining requirements can be a real godsend. If that is you, welcome to the Dogs of the Dow strategy.

After I got started using the Dogs as one of the ways I worked with clients, I began to develop a profile of sorts to help me identify the people that could be both receptive to the idea and well-suited for it. After perhaps a couple years and several dozen clients getting involved, I came up with a series of questions I would ask during our initial and subsequent discussions of the client’s objectives, risk tolerance, and investment expertise. This profiling process is a mandatory part of the “know your client” rule imposed by the SEC on Financial Advisors and is in place to help assure that the investment recommendations made by the FA are “suitable” for the client. I’d add that if any of you are working with a FA, or considering doing so, and you haven’t had even one sit-down with them to go through a formal profiling process, you might want to look for another advisor to work with. It’s that important for both of you.

Below I am going to construct a short list of comments I might hear from prospects or clients that gave me the clues I needed to determine if using the Dogs strategy could be suitable for them either as part of an overall equity investment process or, in some cases, as the only method for equity investing they could be comfortable with. Read each of these and make a mental note as to whether or not it could be something you might say. Be honest with yourself – nobody here to try and impress with your abilities or desires. When done, tally up the “yes’s” and “no’s”. I would propose that if you have said yes to 70% or more of them, you may be well served to give more serious consideration to making this a part of your portfolio management. Here are the statements:

“I need more income from my investments.”

“I don’t have the time to study all this stuff.”

“I try, but often don’t really understand what I read about a company.”

“Seeing my income increase year after year is important.”

“I just don’t trust all these financial gurus who tell me what to buy. Seems all they are really doing is trying to sell me something.”

“I only want to invest in companies whose names and products I already know.”

“I don’t want to be a trader – I want to be an investor.”

“I want to know beforehand approximately what it will cost me to get involved in this stuff. No big surprises, please.”

“I need a long track record of results before I will consider anything – not some Johnny-come-lately idea.”

“I inherited this portfolio and really have no idea why it holds the things it does and whether or not I should keep it all just as is.”

“I don’t want to be getting constant calls from my advisor or anyone else about buying or selling things.”

“Truthfully, I have no interest in any of this other then I don’t want to be involved in something that could wipe me out overnight.”

“I’ve always believed in American companies and, for the most part, are the things I’d be interested in.”

“I need to understand why I would buy a stock and then, later, why I would sell it.”

“Keeping my taxes under control is important to me.”

“I’m willing to take some risk with this part of my assets, but nothing crazy.”

“I understand that, over the long haul, the stock market in general has paid investors a return of about 10% per year on average. I expect that – and maybe better.”

“I need to feel that I am in control of my assets, not some faceless, near-nameless manager 2000 miles away from here that I will never meet or talk with.”

OK, that’s enough. How did you do? Would you say that you agree with 70% or more of those comments? If so, you may have the scent of a trail that can lead you to a new way of doing things.

Is There a Dr. (Freud) in the House?

We human beings are complex and often unpredictable critters. Why we do the things we do, say the things we say, act the way we act, all this and more has been a perplexing problem since the days we dressed in animal fur, lived in caves, and couldn’t find a Starbucks anywhere. Not much has changed in the way our minds work ever since.

This conflict of “I’ll say this, then do that” we fight every day has a place in the investment process as much as anywhere. As I began to work with clients in managing an equity portfolio following the Dogs of the Dow strategy, it didn’t take long for that paradox to rear up and bite me right where it hurt. Let me tell you a little story about my very first client to agree to try the strategy – I’ll call him Robert, not his real name – and what happened on our first anniversary of establishing the account.

Robert was a long-time investor, quite knowledgeable not only about stocks in general but also very well in tune with his inner self and what he wanted from his investments. He was a full-time real estate investor, buying small strip centers with three or four tenants and running them for the cash flow and capital gain they could produce. As such, Robert was quite aware of the idea behind the “buy low, sell high” dictum. He bought distressed centers, improved them, raised the rents or got better tenants as the opportunity arose, then might sell in a few years if he could turn a profit and redeploy the money in another beat-down property – then do it all over again. He was good at it. Lived in a nice home on one of Ft. Lauderdale’s many deep-water access canals and had his beloved 36′ cabin cruiser parked at his dock out back. Life was good.

In addition to that, he had accumulated a nice portfolio of blue-chip stocks, almost all dividend payers (he understood rent, remember?). He hardly ever made any sales of anything. We had a great relationship that went beyond the FA/client kind. I had several fun times at his house for a Christmas party or out with him and a few friends deep sea fishing. Watching the New Year’s beach fireworks from aboard his boat out in the Atlantic was a real treat. He wasn’t just a client – he was my friend.

Maybe that’s all why he agreed to give the Dogs strategy a try when I showed it to him. Had the kind of companies he liked, paid good, increasing dividends, didn’t require a lot of work or trading, and had an understandable philosophy behind it to guide us. I gave him a copy of my brochure, went over it all in detail, and got the account set up with our first 10 stocks. Robert had just become my first account to use this strategy and I felt very good about that.

All went as planned the first year. The portfolio did fairly well with one company in it – General Electric – carrying the water for the most part. GE had a good year, or at least better than the other nine. So, on the anniversary date, I called him and gave the rundown. In concluding I said what we needed to do now was sell GE (it had appreciated well off the list) and use the proceeds to buy whatever (I forget what, exactly). The phone went totally silent for maybe 5 seconds – a very long 5 seconds. Robert then spoke and I’ll never forget what he said.

I can’t quote him verbatim after these 22 years or so, but here’s a close approximation: “Jim, what did you say? You want me to sell GE and buy whatever? Are you kidding me? GE is the best performing stock in the whole portfolio – I’d be nuts to sell it now! No way am I gonna do that. Pick something else to sell, something that has done poorly and sell it. But not GE. Nope. Never!”

Now it was my turn to go silent. I was bamboozled, flabbergasted, disoriented, whatever 3/4/5 syllable word you can think of that means in essence I didn’t have the slightest freakin’ idea how to respond. I mean, he had just blown the entire idea behind the process out of the water, and this the very first time we had ever been required to follow it. I was not ready to hear that. I had no ready-made reply.

It took me a few seconds to compose myself while my brain was moving at warp speed, trying to come up with a counter argument. Nothing appeared. I had nada. I don’t know exactly what I said other than some weak response about how this wasn’t how the game was supposed to be played or something along those lines. Didn’t even make a dent in his resolve. We hung up with him still holding GE and me wondering what had just hit me. Things weren’t supposed to go like that. Robert and I had gone over all the ways we were going to conduct the portfolio, the reasons why, etc., and he agreed to all of it. And now, when time came to actually do it, he went the opposite direction from what he had committed to do. I had to find a solution, and fast. I realized very quickly that if he was going to do this I would surely have others follow suit as their anniversary dates arrived. And if I let that happen, if I let them vary from the discipline like that on day one, it was over. Might as well take my ball and go home.

I recall rather clearly that evening I struggled to come up with a solution to this problem. I understood Robert’s stance in the matter. I also understood that what he was doing was destroying the strategy before it even had a small chance of showing what it was capable of. I had to find a way to make this right. And slowly, an idea was born that I felt might work.

The next day I called Robert and told him we needed to talk about his decision. He said he’d listen, but still was of a mind to do nothing with the position in GE. If I had a way around that, he’d at least consider it. So I launched into my thoughts in hopes of saving the situation.

First, I went over a few of the most important points of the strategy. Foremost of those was the fact that this is a contrarian strategy, a strategy that by definition would go against the grain of what might be called common sense. Following the strategy forced an investor to do things they ordinarily would not – like selling a stock that was performing very well and buying one that wasn’t. I reminded him that the idea of “buy low, sell high” could only be accomplished in most instances by buying when things weren’t going well with a company and the price was depressed, then selling it when things had turned around and the price had increased. I made note that I didn’t say “buy lowest” or “sell highest.” Probability was we’d never be buying at the absolute lowest point of a stock or sell at it’s absolute highest. No strategy I’ve even run across can stand and deliver on those terms. The way this discipline worked was to cut out the middle part of that, not get the whole enchilada. And I told him the final thing: if he was going to interject into the process his own thinking, ignore the rules of engagement as described in the process, and make decisions based on current events, then there was one thing he had to do: he needed to go into his files, pull out the brochure we had gone over a year previous about how it all would work, and toss it in the trash. Because he wasn’t using the process anymore. So none of the historical results applied any longer, none of the thoughts behind the strategy would work anymore, none of the future results he might have hoped for could be counted on. And while he was at it, we might as well transfer all the positions into his regular investment account and co-mingle them with the rest of his holdings. No reason any more to keep them separate and have just another statement to read and file nor pay any more yearly account maintenance fees (yes, in those days brokerage firms actually charged anywhere from $35 to $125 each year just for having the account). Or, he could consider another option.

If he was adamant about keeping GE, I had a suggestion that would allow him to have his cake and eat it too. What he could do was take the current dollar value of the GE position and see what would be brought into the account if it were sold. Then, we’d look over his positions in the other investment account and find something(s) that weren’t doing well and he could justify selling to raise the necessary cash. Then I’d transfer the GE shares into the regular account while at the same time transferring the cash from the sale(s) into the Dogs of the Dow account. Note: This won’t work if one of the accounts is an IRA and the other a taxable account. Must transfer between like account formats so as to not run afoul the IRS.

If he couldn’t identify anything in the regular account he’d be willing to sell, then he would have to access the required cash from elsewhere – his bank account(s) where he had checking, savings, and CD’s deposits. Access one or another of those sources and send me a check while I transferred the GE out and into his personal investment account. Either way, he got to keep GE, the Dogs account got credited with the cash to make the new purchase with, and the process remained intact.

Now we had a plan. We looked at his regular account, identified three sale candidates, and sold whatever was necessary to raise the required cash. At settlement I transferred the cash over and the GE out, then made the new buy. It wasn’t a perfect solution – things hardly ever are “perfect” – but it saved the day and the integrity of the Strategy. We lived to fight another day and everybody went home happy!

As I had thought, this kind of thing arose with other clients from time to time and I used the same logic of transferring out the stock they wanted to keep and bringing in replacement funds from whatever source available. Of course, if there was no other source of funds, then things got more difficult. I decided that in a case like that, a case where the client either truly did not have additional funds to work with (almost never true, but that’s what they would tell me) or they had it but simply were unwilling to add the additional sums to the account, I deemed it preferable to keep as much of the discipline in place and at work for the client’s benefit as possible rather than tossing the baby out with the bathwater. And so it went for as long as I remained in the business. And I learned a lesson, one I never again overlooked: people will tell you one thing and then, when confronted with a situation calling for them to step up and actually do what they had agreed to do, they take off in a totally different direction. As if they had never even heard of the first decision.

People are funny like that. I needed a Psych-Doc of one or another of the human behavior disciplines to help me build my business much more than I needed another analyst opinion or new product to offer. Not for nothing, but if you or someone you know is considering becoming a professional Financial Advisor, suggest to them they load up on college classes in the psychology and marketing departments. Economics and accounting come second in the list of things that will help them succeed in that profession. Sounds odd, but believe me – true!

And while I’m touching on the subject of professional Financial Advisors I’d like to throw out a suggestion for you to chew on. The suggestion is this: regardless of your level of experience and expertise, consider taking on a F/A to assist you in running this account. I know that sounds a little counter intuitive, taking a professional in to help with what is touted as being a true do-it-yourself investment program. But consider this:

In the example I detailed above about my situation with Robert, it’s clear that if he had been working on his own, even given his years of experience, he would have blown the process up right out of the gate so to speak. The only thing that kept him on track…was me. Having me there to remind him it was time to make the annual adjustment, something that had “slipped his mind,” to show him what he was required to do based on the strategy rules, to help him find a way to accomplish what he wanted and at the same time keep the integrity of the process intact, and in a broad sense make him realize what he had committed to doing and giving it a fighting chance of success, all this and more made having me “on his side” make all the difference.

Ask yourself: do you ever “forget” to do something you know needs doing? Ever postpone an activity because you’re just “too busy” to deal with it right now? Ever feel a bit unsure of what, exactly, to do, and therefore avoid doing anything at all? Ever need a little push in the right direction to get things done (guys, I know what your wives would tell me about that one!)? Do you believe in the concept that “two heads are better than one” and often appreciate having some outside input you can rely on to assist in decision making? If you agree with all or most of that, then having a FA working with you on this may prove to be a very worthwhile venture.

If you decide to do that, hire a FA to work with you on the account. Be sure to do this: call several brokerage houses, speak to the manager, ask for her recommendation of a FA in their office that has a broad and deep understanding of this Dogs strategy. Don’t just accept whoever the receptionist channels your call to when you call in. And then, once you have a few recommendations, interview them. Ask questions about the process that they ought not need to look up answers to. Ask them about how many clients they have that use the process. Ask them lots of questions and see who seems to really be devoting time and effort to understanding and working this process. Getting hooked up with the right individual is important. The investigation time and energy is well spent. Having them in place just might at some point save you from yourself.

The Wallenda Effect – Balance is Everything!

Of all the things that surround the running of a portfolio using the Dogs of the Dow strategy, none is more important than the yearly “rebalancing” requirement if you are to hope to approximate the returns that are quoted on sites that follow this process. And while the issue of rebalancing is made to sound simple, remember the old adage: “Nothing is as easy as it seems.”

The way this is often put by writers on the topic is that, on the yearly anniversary date, the investor calls up a yield chart for the Dow 30 stocks, then orders them from highest yield to lowest. Take the top 10 of these and compare that list of companies to what you own. If you own something that is no longer on the list, sell it – or them as the case may be. Then take that cash and buy equal amounts (in dollars, not shares) of the companies that have replaced them on the list. And you’re done for another year. What could be easier?

But let’s hold on here a minute. There is a lot more to this rebalancing than what this implies, and the difference it can make in returns increases in magnitude with each passing year if that is all you do. It’s really not as easy as that suggests. Let’s get down into this a bit deeper and see what you really have to do if you are going to truly follow the strategy.

When Michael O’Higgins published his book Beating The Dow in 1991 and laid out the strategy for the first time, his instructions on this rebalancing thing were much more detailed. You didn’t just sell the stocks that had appreciated off the list and buy the ones that had declined onto it with the proceeds. That was only part of the requirement. What he told us was that the rebalancing applied to all the positions in the account. You had to take the total value of all the positions in the account, divide that by 10, and then add to or reduce positions as required so that you wound up with an equal value for each at the start of the new year. And this presents some problems for most of us – as life in the real world so often does.

A couple of the primary problems that selling everything, then repurchasing most of what you had just sold, is the tax consequence incurred if you are working within a taxable account. Then comes the additional commission costs of all those trades. In today’s world the tax problem still exists as it always has. The commission cost has, however, become much less an issue. Back in the day, at a full service brokerage firm, there was a minimum commission on any trade of any size of ~$35.00. The price to buy or sell say, 75 shares of a $40.00 stock would run ~$60.00 or so. And if you had a substantial account of $100K or more where you were dealing with perhaps 400 shares of a $40.00 stock, the cost could be as much as ~$300.00! For those of you who weren’t around to see that, try and imagine paying this sum for a single trade. But investors did, every day. It was the way the game was played back then and few options were available. That can get rather expensive very fast. So think on that the next time you’re tempted to whine about a $8.00 commission. It should put things into a bit of perspective and make you feel a whole lot better. But today, with trade commissions being so very low, it’s no longer a primary consideration. Even so, why pay for something you don’t really need to pay for? So what do we do to properly rebalance the account on our anniversary dates?

Given that we don’t want to have a 100% turnover rate in the account each year and create a tax liability plus unnecessary costs, I had to come up with an approach that would get the account positions in line with a “perfect” rebalancing that would start off with the same dollar amount once again spread across all 10 positions. After a few years of trial and error, here’s what I finally settled on as a reasonable compromise. Try this on for size.

On your anniversary date, run the yield calculations as always to find the then-current top ten yielding stocks. Sell – without question – the positions you have that are no longer on the list. But before you make any buys to replace them, have a closer look at the positions that remain in the account. Add up the total value of everything still owned and divide this sum by the number of positions you have. This will give you an average value for each. Then, compare this average value to the individual values. If something is worth 10% or more than the average, calculate how many shares you need to sell to get this value down to the average number, then sell enough shares of that position to get it back in line with the others. Don’t fret about being exact. We’re playing a game of tossing hand grenades here, not darts. If you spot a position whose value is more than 10% below the average, calculate how much you need to add to the position to bring it up to the average value. Then buy the number of shares that this sum will allow to realign this position. Once those adjustments are made, use the remaining cash from the sells of the positions that had appreciated off the list to buy, in equal dollar weighting, the ones that had come aboard our little gravy train.

To better explain this concept, follow along with this hypothetical example. We began with the assumption that you started the account with a contribution of $50,000, bought the 10 highest yielding stocks of the Dow 30 at the time, and are now just completing your third year in the program. It’s time to make your adjustments for the coming year. Here’s a table of your positions, current values, etc. Rather than use stock symbols, the positions are just numbered in order from highest current yield to lowest.

STOCK/

VALUE/

TARGET/

$ +or- TARGET/

% +or- TARGET/

ADJUSTMENT REQUIRED

#1

$6,985

$7,010

– $25

0.003

NONE

#2

$5,920

$7,010

– $1090

-15.55

ADD $1090

#3

$6,130

$7,010

– $880

-12.55

ADD $880

#4

$7,486

$7,010

+ $476

+6.79

NONE

#5

$5,320

$7,010

– $1690

-24.12

ADD $1690

#6

$7,110

$7,010

+ $100

+0.014

NONE

#7

$8,235

$7,010

+ $1225

+17.48

REDUCE $1225

#8

$8,140

$7,010

OFF LIST

N/M

SELL POSITION

#9

$6,790

$7,010

– $220

-3.14

NONE

#10

$7,992

$7,010

OFF LIST

N/M

SELL POSITION

Total Portfolio Value: $70,108
Target Average Value/Position: $7010

I chose to use 10% as my trigger value that would cause a position to be adjusted. There is no special magic in that 10% number. I arrived at it over time as I watched the number of trades using something either higher or lower created. Ten percent is high enough to prevent a lot of unnecessary trades yet low enough to cause an adjustment to an individual position before it becomes so over weighted as to have an outsized effect on portfolio returns (positive or negative). You can, of course, use your own number as that trigger if you think appropriate.

The important thing here is that you must from time to time make these individual position adjustments. Not doing so will cause some positions to have undue influence on returns and move you further and further away from the returns you see published about the Strategy. Unless you choose to do a 100% rebalancing at each anniversary, something like this is your only alternative. I believe it is a reasonable one to use; using it with clients in real-world situations made that clear to me. But no matter what you do, do something! Just letting it ride is not to be considered an option!

In the case illustrated above, here’s what the investor would have done and the way the portfolio would look headed into the new year after the adjustments.

Using this table we can see what is required to rebalance our portfolio and bring it back into a rough alignment with what we would have if starting from scratch. It’s not a perfect realignment as you can see. Some positions are still a bit overweight and some underweight relative to the target value of $7010 per position. But close enough for our purposes.

Based on the data the table shows us, here’s what the investor would do.

Sell all of position # 8 & #10. They are no longer in the top 10 group so must go. Proceeds from these two sales would bring $16,132 into the account for redeployment.

Reduce position #7 by $1225. It is valued some 17% above the target value – well above the 10% trigger. This $1225 is added to the proceeds from step #1 giving us a total of $17,357 to reinvest.

Increase (add) to position #2 by $1090, position #3 by $880, and position #5 by $1690. They are all currently valued below the 10% trigger level and need to be brought back up into alignment with the target value of $7110. The total amount spent in making these adjustments would be $2860. Deduct that from the cash raised by the sales in steps #1 & #2 ($17,357) and you have $14,497 remaining to split equally between the two new positions brought into the account, or about $7248 each. This is very close to the target value we have previously determined.

I should point out a bit about the costs involved in doing this adjustment and realignment. We made a total of 8 trades. At Fidelity Investments where my accounts are domiciled, I pay a flat fee of $7.95 per trade. Using that number, the cost of these 8 trades would be ~$64.00. Divide that cost by the total account value of $70,108 and you see the total percentage cost based on overall portfolio value to be 0.0009% That’s not a typo. It really is nine one-thousandths of a percent as my cost of management for an entire year! Vanguard and all other no-load, low cost providers – eat your heart out!

At that point you’re done for another year. Sit back, relax, let the Dogs run and hunt. Resist urges to time anything or make a decision to swap out one position for another due to market action or analysts projections. These are well trained Dogs, they know what to do. Just let them. A final Shakespearian quote for you to remember: “Oft times in our efforts to do better, we mar that which is well.” I’m becoming more and more convinced that Shakespeare, if alive today, would indeed use the Dogs of the Dow to grow his wealth!

In Summary

I maintain, some 23 years after discovering the Dogs of the Dow investment strategy, that it is a viable, productive, and relatively easy-to-run system for equity investment. It has a verified history of performance over a very long time frame, in all kinds of markets. Its ability to deliver market-beating performance, a substantial and growing dividend income stream, and a way for investors to understand what to do, and when to do it, is really quite remarkable. It is, in some ways, the tortoise in a race filled with hares. I’m sure you know that fable – sometimes it’s the slow and steady that eventually wins the prize. And finally, the portfolio gives me a benchmark of my personal abilities to pick and time stock investments in my other portfolios. It can be humbling to see a strategy such as this taking names and kicking P/E’s among my other holdings. Keeps me honest with myself.

As a sort of proof of my belief, of my five separate investment accounts, one still is the Dogs portfolio, representing about 15 to 20% of my total investment assets. It has helped provide something of more stable anchor to my overall investment portfolio. It has been and continues to give me an income stream I can take and use for my own needs now that I am “retired,” or continue to reinvest through a D.R.I.P. plan in the account to compound the earnings. I know each and every company on the list and probably have their products either under the kitchen sink, in my garage, or somewhere else in the house. I am confident that even though the companies may be currently sailing through some rough seas, they will in time right the ship and head back to calmer waters.

Thanks for taking your time to listen to what I’ve had to say here. Perhaps you have discovered that you, too, could benefit by having some part of your investable assets deployed in this manner. It worked for many dozen clients over the years, it works for me personally today. So com’on…join the club. New members always welcome!

Coming Next Month to a Monitor Near You

Next time I will be finishing this investigation of the Dogs of the Dow strategy by having a look at some of the variants and alternative methods of using the strategy that have been developed and made popular over the past 20 years or so. While I remain committed to the original method of owning the individual positions – all of them – there might be a way that lets an investor enjoy most of the benefits of the strategy but with even less work in maintaining it. There are positives to some of these hybrids – and some downside as well.

So stay tuned. The Blind Squirrel will return in late June and tune you in on these alternative approaches.

Thanks, KSS. Considering the source, this is high praise indeed! I am a big fan of yours as well. I cannot pronounce or spell even half the words you use, but hey, I don’t really need to. What I need to do is read and gain understanding which your posts help me do each and every time. I hope your followers will be patient with RGDO (I am long RGDO) and give this story time to play out. Will they be successful and return us who have taken the leap many times our investment? Check back with me on July… Read more »

What do you think of DOD? Purportedly it invests in dogs of the dow and balances and rebalances. I bought a modest amount and didn’t want to have a job doing the rebalancing, and it wouldn’t make much sense to hire an advisor for a modest amount.

David, that is a very good question. Especially for people who need to use the income as it is spun off. I truly wish I had an answer for you I could have total confidence in, but I don’t. I THINK that the site http://www.dogsofthedow.com post results without including dividends – but I am not sure of that. I’ve written them several times to find out but no replies. If you – or any reader here – finds that data, please post. It’s the one hole I have in this process that needs filling!

Al, it’s not as difficult perhaps as I made it appear. And remember, I did say that this is more of a game of tossing grenades than of darts. Close counts for the most part. And it’s that pesky rebalancing that is the only aspect which requires attention of any meaningful amount anyway. Don’t let fear that you won’t be exact in timing or rebalancing keep you from using an effective portfolio management system.

Don, I just KNEW there was something funny about that conversion from decimal to percent number. I just couldn’t get my noggin wrapped around it so I went with what I had, although fraught with trepidation. I knew that with the quality and quantity of readers on this site that, if I erred, it would be brought to my attention :0). Thank you for taking me to the whipping post so gently :0).

This strategy is silly (like most all strategies). It will almost always have you buy/keep AT&T and Verizon, which leaves you 20% invested in telecom no matter what, and keep you out of sometimes-hot stocks like Nike or Visa, which are low yielders. Because of the market’s tendency to roll through sectors, it may provide reasonable returns, but could leave you overexposed to a steadily underperfoming sector. In any event, it’s considerably riskier than buying an ETF that tracks the S&P 500, without the reward to justify it.

Quincy: From what you have said here, is it safe to assume that you won’t be using the Dogs of the Dow strategy for a part of your investment assets in the near future? I think that’s a fair assumption. I mean, who wants to go off and use something so “silly” as to have accumulated a performance history of over 40 years that, in general, beats the Dow and the S&P in total return? “Silly?” Really? Please. Who is being silly here? I’ll let other readers decide that for themselves. But a couple points before I go off and… Read more »

I would not recommend reinvesting these dividends in a taxable account, on stocks where the holding period may be a year and a day. The proceeds from the sale of the initial shares may qualify as long-term gains, but the reinvested dividends will be short-term gains, with different tax treatment.

One other point: The long term capital gains on the sale can be tax free, if the seller is in the 10% or 15% tax bracket ($73K+ of TAXABLE INCOME for married couple filing jointly). Short term capital gains, however, are taxed as ordinary income. So, if one is so inclined, you can sell everything and rebalance to your heart’s content for only the cost of (at most) twenty trades; provided the taxable income (NOT adjusted gross income; that’s significant) doesn’t exceed the 15% tax bracket and the dividends have been swept to a money market or similar pooling fund.

Dave, while what you say is true, you’d have to own a monumental-size account for whatever few shares that were acquired in the previous 12 months ( four dividend pay dates)) were of sufficient size to even be a blip on the tax radar screen. Not meaningful for 99% of investors, so I would maintain that giving up the advantages of reinvestment to save a very few tax dollars isn’t a worthwhile trade-off. In my personal account for example, over the past 12 months, the most number of shares I’ve acquired through reinvestment on any single position is less than… Read more »

I have had bad experiences with DRIP investing, and if I decide to bark with the dogs I would not use a DRIP. Many years ago I had two accounts in Georgia Pacific, a share I had owned forever which had a DRIP, and Citgo, another. Both companies were acquired. I had to work out my basis for Uncle Sam to get his share of my capital gains. The companies were no longer running the DRIP, having been acquired, and were no use at all. It took me two days in each case to make up the records that I… Read more »

I too had a nightmare with a 20 year holding of a drip stock (M.A. Hanna) that merged (PolyOne), suspended dividends, re-started dividends and finally got above where I bought it over the years. I had a small gain (10% after 20 years!) after all was done. Then it went up another 40% in the 8 months after I cashed it out. The point I really want to make is : put a DRIP stock in an IRA or self directed 401K and there are no tax consequences or calculations to make!

Vivian & eyedoc2: You both make excellent points here re using a D.R.I.P plan. I should have clarified this when I brought the subject up. If you participate in a DRIP in a TAXABLE account you most assuredly will be creating an accounting nightmare for yourself or your CPA to deal with someday. Every buy of a small partial share must be accounted for based on the cost basis for each purchase. Over a long holding period that can result in tracking dozens of those tiny buys. If you haven’t kept good records you are in for some serious time… Read more »

I looked into the Dogs of the Dow method since you last wrote about it, and the easiest way to invest in it nowadays is to open an account with Motif Investing. I haven’t invested with them myself, but after doing some research I determined that they offered the best investment vehicle for the Dogs of the Dow strategy. They pool groups of stock, or ‘motifs’ based on different themes/ideas. The Dogs of the Dow is one of those such motifs. Essentially, you invest a certain amount of money, and they will re-balance the DOD portfolio without you needing to… Read more »

Nick:
I haven’t run across this “Motif Investing” idea before. I’ll look into that. Next month third and final article on the subject of the Dow Dogs is going to be on variant approaches and ways to use the strategy other than as originally described by its architect, Michael O’Higgins. Maybe you’ll see a discussion of what they are and how they do it then. Thanks for pointing me in the direction this idea.

Anyone know if a modified Dogs of Dog where you throw out the 2 highest yielders and use the 8 next or 10 next highest yielders does any better? You are possibly getting rid of the worst two performers who may still be spiraling downward and possibly have a better chance of outperforming the market averages. At least some of the Dow Dogs are there because of a bad year creating a higher than average yield, others are there because they are plodders with steady dividends like Verizon and ATT.

Verne: I don’t know of any method that tries to use the S&P 500 universe as basis for this sort of investing. Seems to me to simply be a far too large sampling to manage. The idea – one of them anyway – behind the Dog strategy is to KEEP IT SIMPLE. The more stocks you have to screen, the more you have to own, the more you have to manage, all that makes the entire process more complicated and time-consuming. I’d never try it. Don’t know why I would want to, really. People often tend to take a good… Read more »

I think a lot of people are missing something here. If your nature is to trade (ie you like the gamble and dont need the investment income but hope for the lottery win) this probably isnt for you. I have just reached 65. That means my pension is due. So, I have a choice: to convert to an annuity (a fixed monthly payout of (presently) 3% (licensed theft if you ask me), or manage my own investment avoiding the middleman’s exorbitant charges. Presently I am still working, so all my savings are riskable. But that wont be the case v… Read more »

Alan: First, thanks for not referring to me as “that BS guy” :0). I honestly didn’t think of that when I chose the Nom de Keyboard of The Blind Squirrel. Probably would have used it anyway, but .. I sure set myself up for some poking, didn’t I? Thanks for sharing your thoughts on the concept. It won’t set the world on fire to be sure, but it does its job – capital gain of reasonable proportion and a nice yield to start that tends to get larger over time. Can you spell RETIREMENT PLAN? Cheerio, Mate! Good to hear… Read more »

Oops .. didn’t intend to include that last paragraph in the reply first given. Just ignore. But I did as I said – opened 4 separate accounts to invest in with a portion of the distribution allocated among different asset classes and held separate from one another. That way I could see clearly what was performing (class-wise) and what was not. And then keep control of the percentage of my overall investments that was devoted to which class as well. Works for me …

Jim; What else would a sqirrel do but scurry to put something away? I always read everything you write & greatly enjoy it. ” The Blind Man He Could See” & you help me see a new way of investing…Keep it up. fa

Hi Jim, Since we’re about halfway through the year now, what would be the implications of making my annual balancing day June 1, rather than new years? This is in an RRSP (Canada, similar to an IRA) so the tax implications wouldn’t come into it. I’m also considering using the S&P TSX 60 (http://en.wikipedia.org/wiki/S%26P/TSX_60) as the basis to keep Canadian content in the account. I realize you suggest leaving sleeping dogs lie but still interested in your insights. Thanks for the article!

So Jim, Thanks for your second article on the DOD. I can’t find your final one where you discuss deviant DOD strategies. Will it include the small dogs strategy? Thanks in advance for your consideration of my question. Bob

Bob – Wow. I thought this thread was long dead and over. Looks as if I was wrong! Thanks for the reply, but I have bad news .. There is no third installment. Not long after I wrote the one you refer to I began having some medical difficulty that persists to this day. It saps my strength and ability to sit and write. If that ever changes I’ll be back as a contributor to the site. If not, well, it was fun while it lasted. Brief answer to your question: There are numerous tweaks to the normal Dogs strategy… Read more »

Not sure if you are still checking this but thanks for the articles. And I hope you are feeling better. Question on the DOD strategy…how do you handle mid year contributions? Say on 1/1 you setup your portfolio but you normally add to your portfolio each month or each quarterly. How do you handle those contributions? Just invest in the original 10 and then rebalance everything on the 1 year anniversary? Thanks for any thoughts.

I believe he alludes to this after rule #7, NOTE:
If starting after October 1st invest in the first 8 companies, so my guess is invest in the first 8 to 9 and rebalance on Jan. 1st. Better yet they reference this site several times DOGSOFTHEDOW.COM they actually update the list daily/weekly so I would look at that and invest with the list to date. Hope that helps.